The law changes regularly and so to do the tax thresholds. It is important that you understand that as this document was valid as at 06 April 2017 and update in tax year 2019/20.
The “Standard” Nil Rate Band v The Residence Nil Rate Band
The Residence Nil Rate Band is something additional to the Nil Rate Band and you can read more about the Residence Nil rate Band in our article “Wills – The Residence Nil Rate Band And What It Means”.
We recommend that you read this article first then the one relating to the Residence Nil Rate Band for ease.
The “Standard” Nil Rate Band
When you pass away, you can pass on your assets free of Inheritance Tax (IHT) up to a certain value. That value is known as your Nil Rate Band. The Nil Rate Band is currently £325,000 and has been fixed at this amount for the last 10 years. It will increase in line with inflation from April 2021.
In simple terms, and nothing is really simple when it comes to tax, that means that you can pass up to £325,000 worth of assets to your loved ones (2019/20 tax year) without having to pay IHT.
You might have a Nil Rate Band lower than £325,000 (tax year 2019/20) on your death if you make gifts during your lifetime that are not covered by your tax-free gift allowances and you die within seven years of making those gifts. The value of those gifts will reduce pound for pound your Nil Rate Band, meaning less (or none) of your estate will be passed on tax-free to your intended recipients (known as beneficiaries).
Gifts and Inheritance Tax
Before looking at the seven-year rule, it is important to know that certain gifts can be subject to IHT – usually at a rate of 40%.
HMRC has put in place a set of rules to prevent people from avoiding an IHT liability by simply giving all of their money away literally on their deathbed.
Some gifts will usually be tax-free at the time that they are made. For example, gifts between married couples or civil partners, regular gifts made out of excess income or the first £3,000 gifted in each tax year.
Others could create a tax liability either immediately or in the future.
The Seven Year Rule
Gifts to individuals that are not immediately tax-free will be considered as ‘potentially exempt transfers’ or PET’s. This means that they will only be tax-free if you survive for at least seven years after making the gift. If you die within seven years, the gift will be subject to Inheritance Tax. This is known as the seven-year rule.
These potentially exempt transfers reduce your “standard” Nil Rate Band.
If you die within seven years of making a potentially exempt transfer, the transfer becomes chargeable. Its value will either reduce or eliminate your Nil Rate Band which means that less of your assets will be passed on to your beneficiaries tax-free.
Giving away more than the nil rate band
If you die within seven years of making gifts that exceed the nil rate band, your full Nil Rate Band will be used up by the gift and there will be none left when it comes to passing on your estate.
In addition, the recipient of the gift may need to pay IHTon the value of the gift above the Nil Rate Band. However, the amount of tax they will pay depends on how long you survive after making the gift. This called Taper Relief.
What is taper relief?
The rate of IHT the recipient will pay gradually reduces over the seven-year period – this is called taper relief.
So for example:
It’s important to remember that taper relief only applies to the amount of tax the recipient pays on the value of the gift above the Nil Rate Band. The rest of your estate will be charged with the full rate of IHT.
The information provided in this article is not intended to constitute legal advice and you should take full and comprehensive legal advice on your individual circumstances by a fully qualified Solicitor before you embark on any course of action.
Shak Inayat
